Costco Impresses, but Should Investors Stock Up?

Wide-moat  Costco (COST) posted a strong end to fiscal 2018, which should lead us to lift our $175 per share valuation by a mid-single-digit percentage. Our take is more optimistic than after-hours trading (low-single-digit dip), likely due to our more conservative announcement revenue forecast. Still, the report should not alter our long-term targets, calling for mid-single-digit revenue growth and low-single-digit adjusted operating margins over the next 10 years.

Costco posted $141.6 billion in revenue and diluted EPS of $7.09, beating our $140.6 billion and $6.97 respective expectations. Management cited broad-based strength behind the 9.5% full-year comparable-store sales growth (6.8% excluding fuel and foreign exchange impacts). Comparable e-commerce expansion slowed in the fourth quarter (to 26% versus 32% for the year). However, we are encouraged that growth remains robust, with possible upside as Costco makes more big-ticket items available online that are only stocked seasonally in-store, such as patio furniture and certain home furnishings that can now be sold year-round.

We also suspect investors may be more concerned than we are by news that Costco plans to disclose a material weakness in internal control, stemming from the scope of employees and contractors granted access to reporting systems. With no indication of a mis-statement and the firm's expectation that it will file its 10-K on time, we do not plan to alter our valuation or Exemplary stewardship rating based on this news. Nonetheless, the disclosure is a rare blemish for a management team we hold in high esteem, with a history of disciplined capital allocation and reinvestment behind Costco's brand- and cost-based competitive advantages that has allowed it to thrive despite intense competition. The news is consistent with our contention that current sentiment incorporates a degree of perfection with which we are uncomfortable, and so we suggest investors await a more attractive entry point.